What is PAYE?
PAYE or “Pay As You Earn” is a method that deducts Income Tax from your wages before you receive them. This means that your employer sends the tax directly to HMRC from your pay. This system covers National Insurance and any applicable student loan repayments, in addition to Income Tax.
Fun Fact: PAYE was first introduced in the UK in 1944 as a way of collecting Income Tax during the Second World War. Since then, it has become the primary way of collecting Income Tax and NICs from employee’s in the UK.
The alternate to this method is the Self-Assessment system. In Self-Assessment, individuals are responsible for completing a tax return and paying tax biannually.
How is PAYE Calculated?
The calculation of PAYE depends on your earnings and eligibility for the Personal Allowance. For the 2024/25 tax year, the Personal Allowance remains at £12,570, the same as the previous year. This allowance is the threshold up to which you do not pay any tax.
Income above the Personal Allowance faces progressive taxation:
- Basic Rate (20%): £12,570 to £50,270.
- Higher Rate (40%): £50,270 to £125,140.
- Additional Rate (45%): Over £125,140.
If your income exceeds £100,000, your Personal Allowance decreases by £1 for every £2 above this threshold. Employers typically spread PAYE evenly over the year. If discrepancies occur, leading to overpayment or underpayment of tax, HMRC will issue a refund or bill at the end of the fiscal year.
PAYE on Your Pension
PAYE also applies to pension income. When you receive your pension, the provider has already deducted tax. The pension provider, which might be a pension scheme or an annuity firm, sends this tax to HMRC.
In scenarios where you receive pension payments from multiple sources, HMRC might direct one provider to manage the tax deductions for your State Pension payments.
Key Points
- State Pension as Sole Income: You must submit a Self-Assessment tax return to HMRC.
- Working While Receiving State Pension: Your employer will handle the PAYE deductions from your earnings along with those from your State Pension.
- Additional Income: If you have other sources of income, you are responsible for declaring them, and you may need to file a Self-Assessment tax return.
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